Another 'Stress-Test' Cruises In Under the Radar
Not surprisingly, yesterday's 'pro austerity' vote in Greece's parliament, which paves the way for more good money being thrown after bad (or, as one of our readers perceptively remarked recently, 'more of other people's money') has led to a sharp pullback in bond yields and CDS prices across the European periphery, while the bonds of 'safe haven' debtors were concurrently sold (ironically, we find among those the US, the UK, Germany and even Austria). Everybody decided it was time to pile back into 'risk assets' with abandon, an effort that continues at the time of writing.
At the risk of sounding like party poopers, we want to point out that Greece is just as bankrupt today as it was yesterday. Nothing has changed on a fundamental level. The eurocrats have 'bought more time', which in this case is the equivalent of handing out more rope to hang oneself with.
Below are a few things that have caught our eye in recent days that look like they are worth keeping tabs on. Firstly, a slightly disturbing news item flew in under the radar screen while everyone was focused on Greece.
The euro area's latest bank 'stress test' farce has been concluded, and apparently 15 of the 91 banks tested were found to be undercapitalized. This may not sound like a big number, but consider that these 'stress tests' use the most benign of assumptions. They are after all essentially an exercise in the manipulation of public opinion, a cheap confidence trick. As Reuters reports:
"Up to one in six European banks is set to fail an EU-wide financial health check, according to euro zone sources close to the stress-testing, as officials scramble to set up backstops for those at risk.
The result, which the European Central Bank and others hope will persuade investors the European Union was finally coming clean about the extent of banks' problems, will pressure reluctant states to prop up lenders that cannot raise money. Euro zone sources said the European Banking Authority was set to announce within weeks that 10-15 of 91 banks being scrutinized had failed, with casualties expected in Germany, Greece, Portugal and Spain.
The checks will provide the first picture of the health of EU banks since a previous round a year ago was deemed too lax. In that round, Irish banks were all given a clean bill of health months before their difficulties drove the country to seek an international bailout.
The new checks will measure how well the core capital that banks rely on to absorb losses such as unpaid loans holds up when exposed to an economic dip or fall in property prices.
They also gauge the impact on banks should government bonds they own, issued by states such as Greece, lose value. But the tests stop short of assessing the full impact of a country defaulting, including the likely resultant freeze in interbank lending.
In the drive for credibility, the EBA, which runs the tests and the ECB, which sets the economic scenarios, have pushed for more banks to fail than last year's seven.
"How many do we expect to fail? I would say 10 to 15," said one senior euro zone central banking source.
The EBA wants the number of banks that do not pass the tests to be around that level to show the examinations were serious, said a second source, adding the authority did not want to push for more, for fear it could spark panic.
"In order to demonstrate that it is credible, the EBA would need to show that the number of bank failures is significant, without being substantial," said the source. "A number in the teens is about right."
In other words, 'we need to lie more convincingly this time around'! Let's admit just enough to be 'credible' but please, let's avoid a panic.
This suggests to us that it is high time for depositors in the euro area to panic before everybody else decides to do so. At the very least, depositors should carefully screen their banking relationships to avoid negative surprises. As we have pointed out in the context of the Italian banks a few days ago (see 'Out of Control'), quite a few bank stocks look as though the institutions concerned were already at death's door.
It is quite funny that Italy of all places has just decided to raise taxes on its banks in order to fix the government's yawning budget deficit. This is almost as though Worldcom were asking Enron to help it out.
Italy's austerity budget will introduce separate taxation of profits from banks' proprietory trading at a rate of 35 percent, according to a budget draft obtained by Reuters on Wednesday.
The new tax rate will not include income from bond trading, the draft says. The budget, to be approved by the cabinet on Thursday, will also include a tax of 0.15 percent on financial transactions, a government source told Reuters.
Beggars of the world, unite.
Meanwhile, the Fed has quietly extended its currency swap lines with European central banks, no doubt as a result of the recent brouhaha over the huge exposure of US money market funds to the euro area's wobbly banking sector. The funding of dollar liabilities has been a huge headache for European banks ever since the crisis began in 2008, and these currency swap lines make it possible to circumvent the vicissitudes of the marketplace. As the WSJ reports:
“The Federal Reserve, amid persistent worries about Europe's sovereign debt crisis, last week quietly approved the extension of a crisis-lending program that allows the European Central Bank to tap the U.S. for dollars, Federal Reserve Bank of St. Louis President James Bullard said.
The Fed's dollar-lending agreements with the ECB—as well as the central banks of England, Canada, Japan and Switzerland—were scheduled to expire Aug. 1. The Fed and other central banks haven't yet disclosed renewal of the agreements, known as swap lines.
Fed officials voted to extend the program, [etc.]
As you can see, everything is well in hand. Or as Douglas Adams would say, don't panic!
